1

A tutorial to help you understand the book keeping/accounting concepts

of Debits and Credits
Most people don’t find the math of Accounting as difficult as understanding
the concept of accounting, and for many, there is no more difficult concept
to grasp than that of Debits and Credits. Now the concepts of Debits and
Credits is actually more than 500 years old, being used extensively by the
Venetian merchants of Italy in the 15th century Renaissance period. The
concept was first documented in Latin in the 1400’s and was later translated
into English, in the 16th century. Is it wonder then, with the passage 500
years, that we may have become a little confused about the original meaning
and concepts particularly with the English Language adopting new legal and
every day meanings for those age old words. So it may be beneficial then, as
we try to understand the concept of Debit and Credits, to go back to where it
all began...but first some back ground.
This Training session is targeted at students who have a desire to learn more
about bookkeeping, while specifically developed for students other people
interested in understanding more fully the accounting concepts, may also
find this training session beneficial.
Prior to commencing this training session, it is recommended that you first
complete the Basic Accounting Concepts – Definitions:
This Training session assumes that you know a little about bookkeeping, no
problem, if not, but that you realise to progress in your work application or
your learning, you need to understand more fully the concepts of Debits and
Credits. So, this session seeks to deliver training on the concepts Debits and
Credits, from the student bookkeeper’s point of view.

Key Words:
Debits, Credits, Accounts, Accounting Concepts, Bookkeeping, Firm,
Financial Transactions, Accounting System, Account Group, Double entry
bookkeeping, Duality of Financial Transactions.

Learning Out Comes

At the completion of this training session, you will be able to answer the
following focus questions:
What is the origin of Debits and Credits?
Why was it called Debit and Credit?
What are the underpinning concepts for Debits and Credits?
How would they have applied Credits and Credits in 1400’s?
Is there another way to look at applying Debits and Credits?
 2

Introduction – Debits and Credits:

The dictionary defines Debits and Credits, for the bookkeeping system:
Debits “being those entries recorded on the left side” and Credits “being
those entries recorded on the right side”.
Now some people are comfortable with this definition and after learning all
the other rules and axioms of bookkeeping, go on to become very good
bookkeepers.
However, there are others that want to know more about this basic
accounting concept of Debits and Credits, so they can apply them in a more
meaning full way, if you are in the latter group, this knoll is for you. It will
also make it clear that “while rules must be learnt, at some stage the reason
for them must be made clear; if this is not done it has little educative value.
Before proceeding, it would be very useful for both the rule-learning and
concept understanding bookkeeping students to learn “off by heart” the table
given below and to also have a solid understanding of the definition of each
account t group used in the bookkeeping/accounting process.
Note: One thing that is very clear is that the terms “Debits and Credits” as
used in bookkeeping, has its own special meaning and it should not be
confused with any other meaning of the term. i.e. (Debit as in owing
money to someone or Credits as in having time to pay for the purchase of
goods are not definitions of the Accounting Debits and Credits), Also the
accounting meaning of a term may have a different application to the legal
meaning within the same country.

Do I Debit or Credit:

When you Increase this When you Decrease this

Account Group account group, you... account group, you...
Asset Debit Credit
Liability Credit Debit
Owners Equity Credit Debit
Revenue Credit Debit
Expense Debit Credit

Based on the table above, approaches you would ask the following questions
when ever required to record financial transaction in companies accounts:
What accounts are involved? (there must a minimum of 2)
 3

What account group do they each belong? (There must belong to one
of the five)
Has the financial transaction increased or decreased the amounts in
this accounts? ( Apply the table Logic)
Make sure that the total amount of the Debits equal to the total
amount of Credits.

Account Definition
Group
Asset Items of Economic value which a company has legal
control
Liability Monies owed by a company to external entities, (Creditors
& Loan Providers)
Owners Equity Monies owed by a company to internal entities, (Investors
& Owners)
Income Money paid by others for goods & services provided by the
firm
Expense Assets & Supplies consumed in the earning of income

Part 1.
Origin of Debits and Credits:
In more primitive trading times, bookkeeping was not such a big issue
because the person who manufactured or produced the goods was usually the
person selling or trading the goods in the place market place. However, the
Renaissance Period saw a huge increase in both trade and banking systems
brought about by the Roman-Built transport systems and the growth of more
sophisticated societies like those in Italy (Particularly Venice). So, the
merchants of Venice in the 1400’s, developed an accounting system to
accurately, recorded these more complex financial dealings that were
prevalent of the time.
Now a Franciscan friar and mathematician from that era, Luca Pacioli
(1446 – 1517), is widely regarded to be the “Father of Accounting” because
he was he was the first to codify and publish this accounting system in his
book titled, “The Collected Knowledge of Arithmetic, Geometry,
Proportion and Proportionality” (translated). The book was published in
1494 (about time that Columbus discovered America) and it was one of the
earliest books published on the Gutenberg Press.
Luka makes no claims about inventing the system but he does present it in a
way that others can easily understand it. His motive for recording the
 4

bookkeeping system that was used by the Venetian merchants during the
Italian Renaissance Period was to help Guidobaldo, the Duke of Urbino, in
the management of financial affairs.
This documented system, describe in only one section of the five-section
book, has become known as the ‘double-entry’ accounting system. The 36
short chapters on the accounting system contained in the book, became the
only accounting text-book for the next hundred years and its principles have
been continuously followed by accountants’ right up to today.
Interestingly, Luca Pacioli was actually a colleague of Leonardo de Vinci
and it was Leonardo who helped him illustrated his second most important
manuscript De Divine Proportioned (“Of Divine Proportions”).
Most of Luca’s work still underpins the accounting system we used today.
Those basic accounting concepts from his book in 1494 that are still
practiced today include;
The accounting Cycle
The use of Journals and Ledgers
Debits equal to Credits, “Double entry bookkeeping”
The account groups of assets (Including Receivables, Inventories,
Liabilities, capital, Income and Expense).
Year-End closing entries
The Trial Balance, which he believe should be used to prove a balance
ledger

Summary
In Part 1. We learned about the 500 years history of Debits and Credits and
the significant contribution made to the world of accounting by the
Franciscan fair and mathematician Luca Pacioli with his ‘double entry
bookkeeping system’.
Part 2.
Why was it called Debit and Credit
Now remember, Luca was more a mathematician than accountant, so his
mind would have been trained to look for the key principles, concepts and
symmetry that underpinned, the venetian, merchant’s financial recording
system.
Key concepts he would have identified were (1) that in the accounting
world, the business or the firm was an entity in its own right and that entity
was separate and distinct from the owners. Another principle he would have
seen is that (2) the financial world is a closed system. That is, money just
 5

doesn’t just materialize form nowhere. If money is received by someone it

must have been given by someone else vice versa.
This closed system of giving and receiving would have led him to see the
concepts of ‘duality’ in financial transactions relating to a firm. For example,
when an amount of money is entrusted by someone to a separate and distinct
firm, then that firm would now have an obligation and owe that person the
same amount of money in return.
Using his native Latin, Luca named the act of entrusting- ‘Credre’ (Which
means ‘to entrust”)and the corresponding obligation on the firm –‘Debre’
(which means ‘to owe’). So from the point view of the firm, he could see
that this principle of duality held true for every financial transactions entered
in to by the firm. For him, it was not just a formula an aspect of existence
where one side could not exist without the other. In a closed system, every
‘Debre’ must have a corresponding ‘Credre’ where two sides of the same
coin. (In Finance-when someone ‘entrust’ money then someone else ends up
‘owing’ it.
Luca would also have noted this duality of financial transaction extended to
the fact that financial resources transfer from place to place, in other words,
for every financial transaction there must have been a transfer of economic
resources from a source to destination. Again he applied the concept where
the source would be credited and the destination debited as financial
resources flowed from one place to another place.
He was so convinced of this concept of duality, that he said to declare that
no one should go to sleep at night without ensuring that the ‘Credre’ equaled
the ‘Debre’, (Credits=Debits)
Note: the translators used the Latin roots for those concepts and so named
them Debits and Credits. It is highly probable that we also got the
abbreviated forms of these items (Dr and Cr).
Summary
In part 2, we see the emergence of the concepts of duality where debits and
credits are just two sides of the same coin in the way that the Chinese
concept of ‘Yin and Yang’ are complementary opposite within a greater
whole, we begin to see the concepts that under pin the application of Debits
and Credits and the link to the original root with its original meaning.
Part 3.
What are the underpinning concepts for Debits and Credits?
To properly understand Debits and Credits you will need to first understand
the concepts that underpin the whole accounting process. Some of these are
called Accounting Conventions and others are simply re-enforcing the way
that the accounting systems looks at and records financial transactions.
 6

Basic Accounting Concept 1 - The Business or Firm is an entity.

In simply terms, the legal system defines an entity as a person or non person
that is capable of suing or being sued under the laws of the land.

Basic Accounting Concept 2 – The Business (Firm) is a separate entity

distinct from the owners.
A firm, while it has ‘legal’ control over items of value, it is the ultimate
owner of those things. In other words, if the firm sold everything it had, it
would be obliged to distribute all those monies to meet the claims made by
other people or entities.

Basic Accounting Concept 3 – People can wear multiple hats.

It is an important one to understand when getting the right perspective on
financial transactions. Just like one person can be a parent, sibling, cousin or
offspring, so too a person can be an investor in a firm, a creditor/debtor of a
firm, the manager of a firm or a director of a company that controls the
operations of a firm. The important thing to remember is, that in accounting
the financial transactions are always analyzed and recorded from the firm’s
point of view with you as the manager (not owner).

Basic Accounting Concept 4 – Every financial transaction has two sides

to it and involves a sources and a destination of economic resources.
The financial world is a closed system. That is, money doesn’t just arrive
from nowhere and it is not just paid into thin air. If money is received by one
person or entity, it must have been given by another person or entity and that
in ever transaction involving financial resources there must be a source and
destination. This gives us our first insight into the Debits and Credits system
that we use in accounting today.

Basic Accounting Concept 5 – The profit from the Firms activities

belongs to the owners.
As understood from concept 2, the firm does not really own anything, from
an accounting perspective. It may have legal rights of ‘ownership’ or
control, but fundamentally in accounting terms it is an accounting entity set
up by the owners to manage their affairs. So, when a firm makes a profit it
does so for the owner’s benefits, not for the firm’s. Remember, if everything
was sold off the firm would be left with nothing because everything of value
would be used to first pay off liabilities with the remainder going to the
owner.
 7

Summary
In part 3, we get to understand the accounting concepts that not only
underpin the concepts of Debits and Credits, but the whole accounting
system as well. We learnt that:
The business or firm an entity,
The business (business) is a separate entity distinct from the owner,
People can wear multiple hats and operate in multiple capacities,
Every financial transaction has two sides to it. ( a source and a
destination),
The profit from the firm’s activities belongs to the owners.

Part 4.
How would have applied Debits and Credits in the 1400’s?
The story goes...
Once up on a time Antonio had spotted an opportunity to sell Italian olives
to Egypt. So, Antonio assume himself (as manger of the new firm)
approached an Italian olive provider and convinced him to supply $ 100,000
worth of olives but with the promise to pay him on his return from Egypt.
Antonio did not mention the profit he was going to make because the olive
provider’s only interest was in being paid for the olives.
So, Luca had his first financial transaction, noted the following using the
Latin meanings for Debits and Credits.
• The source of the economic resources was the Italian olive producer
whom the firm now owed $ 100,000 – Credit (Cr) Accounts Payable.
• The destination of the transfer of economic resources was the olives
that the firm now had as inventory – Debit (Inventory).

Using the Table above, We would pass the following entry:

Asset - Inventory (increase) $100,000 Dr
Liability – Accounts Payable – oil provider $100,000 Cr
Soon after, Antonio took Luca to see the $50,000 ship he had bought,
using $ 30,000 of his own money and $20,000 from a bank (loan Funds).
Antonio was excited because he now knew that he had the means to
make his Idea reality and make that fortune he dreamed of from selling
these olives.
Luca realized that the firm had been involved in its second financial
transaction and again noted the following from the firm’s point of view:
• One source of economic resources was the bank who the firm now
owed $20,000 in the form of loan – Credit (Cr) Bank Loan
 8

• Another source of economic resources was the $30,000 from the

owner Antonio who the firm treated as a separate entity to itself –
Credit (Cr) Capital
• The destination of the economic resources sourced from the bank
the owner was purchased from $50,000 – Debited (Dr) Ship

Using the Table above, We would pass the following entry:

Asset – Ship (Increase) $50,000
Liability – Bank Loan (Increase) $20,000
Owners Equity – Capital – Antonio (Increase) $30,000
Luca was happy because in both financial transactions (1) the total of debits
equaled the total of credits and (2) the underlying concepts of the ‘double
entry bookkeeping’ system had been adhered to.

Summary
Armed with the underpinning ‘double entry bookkeeping’ concepts and the
concepts of the sources and destination of economic resources, we attempt to
see what Luca saw as he contemplated the entries that would be made in the
factious books of this 15th century business.
Part 5.
Today we look at Luca’s notes and we discover an emerging pattern. It
appears that Luca could use concepts of source and destination of financial
resources to describe every transaction.
It seems that....

Sources of Destination of
Value Value
Credit (Cr) Debit (Dr)

On with the story.

Antonio was soon back in town after successfully contemplating his ‘Sales
Trip”. Antonio explained that he (as manager) had sold all the olives for
$200,000 and the trip had only cost $30,000 including the $1,000 interest he
paid to the bank. He explained that he had paid these amounts out of the sale
proceeds and that he had visited the Olive provider to repay his account. He
 9

also said that he had used $10,000 of the sales proceeds to buy furniture for
his house in celebration of a successful trip.
We soon realize that a third series of financial transactions for the firm has
happened involving four main parts.
1. The sales of the olive for $ 200,000 cash
2. The olive provider was paid for his outstanding account.
3. The use of $30,000 of cash proceeds to pay for the trip costs and
interest expense
4. The withdrawal and use of $ 10,000 by Antonio (as owner)

Taking over from Luca, we will look at these transactions and apply the
sources and destination approach to determining the Debit or Credits of the
transaction and comparing the results with the table rule approach identified
above.
Here is what we would have come up with;

Action taken by
the Firm Source or Dr/ Amoun Account & Group
Destination Cr t
Transaction 1
The sources of
funds coming into
The Firm make the firm was from Cre Sales (Revenue-Increased)=Credit
sales of $ 20,000 the sales of olives dit $200,00
to customers (Cr) 0
The firm receives
$200,000 in cash The destination of Deb Cash on hand (Assets-
for the sales of the sales proceeds it $200,00 Increased)=Debit
the olives was Cash on (Dr) 0
Hand
Transaction 2
The firm used its The sources of
cash from the funds used to Cre Cash on hand (Assets-
sales to pay the repay the olive dit $100,00 Decreased)=Credit
olive provider supplier was Cash (Cr) 0
on Hand
The firm paid the The destination of
outstanding the funds from Deb Accounts Payable (Liabilities-
promise to the oil cash on hand was it $100,00 Decrease)=Debit
 10

provider the debt owed to (Dr) 0

the oil producer

Action taken by
the Firm Source or Dr/ Amoun Account & Group
Destination Cr t
Transaction 3
The firm used its
cash on hand to
pay the travel The source of the Cre Cash on hand (Asset-
costs and bank funds was cash on dit $30,000 Decrease)=Credit
interest hand (Cr)
The firm had to
pay for the The destination of Deb Interest expense (Expense-
interest costs to the funds was it $1,000 Increase)=Debit
the bank partly the bank (Dr)
interest
The firm had to The destination of
pay for the costs the remaining Deb Travel Costs (Expense-
of the ‘sales Trip’ amount of funds it $29,000 Increase)=Debit
was for travel (Dr)
expense
Transaction 4
The firm paid out The sources of Cre
$10,000 in cash the funds was dit $10,000 Cash on hand (Asset-
Cash on Hand (Cr) Decrease)=Credit

Antonio (as
owner) used $ Deb $10,000
10,000 of the The destination of it Capital-Antonio (Owners Equity-
firm’s cash for the funds was to (Dr) Decrease)=Debit
personal use. the owner
Antonio
End of
Transaction
 11

All the account groups have been affected in this transaction, yet you can see
that we still achieve the same outcome using the ‘source and destination
‘approach as we learned in the table above, but there is an underlying
meaning to the questions and they are in keeping with Luca’s original Latin
meaning.
Summary
We set out at the start of this article to understand more fully the basic
accounting concepts of Debits and Credits. We know that we can be a
successful bookkeeper by simply applying the learned approach, but some
people want to understand the ‘why’ by going back to time of its conception,
and looking at the original meanings we have been able to give meaning and
new approach to determining the Debits and Credits of Financial
Transaction.
 12

BACKGROUND
Establishment
Roha General Trading Private Limited Company was established in ………. by
its shareholders to render services in areas of real-estate, industry, agriculture &
forestry development, mineral & mining, agro-industry, transport, hotel &
tourism, construction & engineering, water development, medical &
pharmaceuticals, commission agency, brokerage, general trading, customs &
clearing, loading & unloading, packing & forwarding, education & health
consultancy, printing, recreation and other related activities.

Objectives of the Manual

The following are the objectives of this manual:
• Define clearly the financial and accounting policies of Roha General
Trading PLC,
• Put in place an adequate internal control system,
• Put in place a system that will provide adequate control over the resources
of the Company, and
• Create a system that will enable the Company meet its reporting
requirements to Management, the shareholders and its external
stakeholders.

Methodology
The manual has been developed on the basis of the generally accepted accounting
practices as applied in Ethiopia and tailored to the specific needs of Roha General
Trading Private Limited Company.
In developing this Manual:
• The present financial and accounting practices and administrative routines
have been reviewed.
• The best practices of similar organizations have been incorporated where
relevant.
• Walk through tests for the relevance and appropriateness of the procedures
included in the manual have been made.
• The manual has been discussed and agreed with the Management before
finalization.

1. ORGANIZATION
Organization structure & staffing
The Finance Unit of MEKAMBA PLC is staffed by the following three full time
employees:
• Finance Head,
• Senior Accountant, and
• Cashier.
 13

The Unit is structured in such a way that it can provide adequate internal control
through separation of duties and independence between the Cashier, who handles
all cash payments and collections, and the Senior Accountant, who will be
responsible for the recording, reporting and control activities.

Authorities & responsibilities

Finance Head
The Finance Head has the following functions and responsibilities:
• Ensure that the Company has adequate level of resources for its operation.
• Ensure compliance of budgetary and internal control procedures.
• Assist and advise in developing and implementing accounting control
procedures and see that appropriate accounting systems have been
established.
• Ensure that accounting records are maintained and financial reports are
prepared on schedule, delivered to the Managing Director and the
shareholders.
• Prepare and submit the following financial reports on due dates indicated
below:
o Monthly financial report by the 12th day after end of every month.
o Monthly cash flow forecast covering 6 months into the future by
the 3rd day after end of every month.
o Finalize the annual financial report and make it ready for
examination by external auditors within one month after end of
year.
o Compile and get approval of the annual budget one month before
the year end.
• Verify payment vouchers and monthly payroll.
• Approve journal vouchers for processing in the accounting records.
• Review and approve bank reconciliation statements.
• Receive and keep under his/her custody unused payment and receipt
vouchers, cheques and used cash receipts.
• Maintain, keep and update fixed asset register books.
• Assist the Managing Director in discharging his/her finance-related
responsibilities.

Senior Accountant
• Assist the Finance Head in preparing financial reports.
• Prepare cheque payment vouchers.
• Check petty cash payment vouchers.
• Prepare payrolls.
• Ensure that payroll deductions and taxes are timely paid to the tax
authorities.
 14

• Ensure that withholding taxes, value added taxes, profit taxes, etc are
properly accounted for and paid to the Tax Authority within the due date.
• See that revenue stamps are affixed to payrolls and contract documents.
• Encode accounting data for computer application and post transactions.
• Print and file journals, ledgers and financial statements.
• Prepare journal vouchers.
• Prepare monthly bank reconciliation statements.
• Age receivables and make follow up of their collection.
• Ensure that all financial documents are stamped “paid”.

Cashier
• Collect cash against Cash Receipt Voucher and deposit same into bank
intact.
• Maintain and keep the petty cash fund.
• Make payments from the petty cash fund as per approved Petty Cash
Payment Slip.
• Prepare “Petty Cash Settlement List” and submit same for replenishment.
• Write cheques as per approved Payment Voucher.
• Collect bank advices, bank statements and other documents from the bank.
• Prepare CPOs, bank drafts, transfers, etc

2. ACCOUNTING

Accounting Method
The Company adopts accrual method of accounting.

Accounting Policies
• Fixed Assets are stated at cost less accumulated depreciation. Depreciation
is calculated on the net book value of the assets at the following rates per
annum:
%
Office furniture & equipments 20
Computer and its accessories 25
Motor vehicles 20
• Stocks are valued on the cost flow assumption of First-In-First-Out (FIFO)
basis.

Further to the above the Company from time to time shall select and apply
appropriate accounting policies to ensure that its financial statements provide
information that is:
• Relevant to the decision making needs of users,
• Reliable in that they:
o Show the true results and financial position of the Company,
o Reflect the economic substance of events and transactions,
 15

o Are neutral and free from bias,

o Are prudent, and
o Are complete.

3. FIXED ASSETS

Recognition
An item of fixed nature shall be recorded as fixed asset if:
• Its original unit cost is greater than Birr ………..
• It is physically and separately identifiable.
• It has a useful life of more than one year.

An item of fixed nature whose individual cost is less than Birr 1,000 shall be
recorded as expense for the period. However, memorandum records shall be
maintained for internal control purposes.

Cost of fixed assets

The cost of fixed asset consists of all costs incurred in acquiring the asset. If it is a
donated asset, an independent technical valuation or market value may be taken to
capitalize the asset.

If yearly expenses for repair and maintenance exceed 20% of the depreciation
base of each fixed asset category, it can be considered as an increase in the value
of the asset.

Depreciation
Annual depreciation shall be computed as follows:
• Buildings at 5% per annum on a straight line basis on the acquisition cost.
• Computers and related accessories at 25% per annum on the book value or
the declined balance at the beginning of each accounting period.
• All other assets shall be depreciated annually at the rate of 20% for the
group on the book values at the beginning of each accounting period.
• If the depreciation base is less than Birr 1,000, then the entire value shall
be depreciated.

If the depreciation base is a negative amount, that amount shall be added to

taxable profit and the depreciation base shall become zero.

The depreciation shall consider all increases and decreases during the accounting
period.

Fixed assets acquired at any period during a fiscal year shall be depreciated at full
rate irrespective of the date of purchase.
 16

Depreciation charged on fixed assets that are temporarily out of use or idle should
be classified as administrative expense and not as cost of sales.

Depreciation on revalued assets is not allowed for tax purpose. However for
accounting purpose the appropriate periodic depreciation charge should be
recorded to account for utilization of these assets.

Disposal procedures
Obsolete or non serviceable fixed assets shall be disposed off upon approval of
the Managing Director. Gain or loss on disposal shall be recognized in the
accounts when fixed assets are sold.

Registers and control

The Finance Head is responsible for keeping and updating fixed assets register
books with information such as fixed asset number, cost, acquisition date,
location, accumulated depreciation and book values of all fixed assets. The
physical existence of all fixed assets recorded in the register book shall be
periodically verified by an independent person.

A complete physical count shall be made at least once in a year, preferably at year
end. Obsolete, non serviceable and missing fixed assets found during the physical
count shall be reported to the Management for decision and appropriate
accounting action.

All fixed assets shall be identified by a unique fixed asset number which shall
appear on the register book and the asset itself.

Recording procedures
Purchase
Dr: Fixed Assets
Cr: Cash/Bank/Accounts Payable

Depreciation
Dr: Depreciation Expense
Cr: Accumulated Depreciation

Discarding before asset is fully depreciated

Dr: Accumulated Depreciation
Dr: Loss on disposal of assets
Cr: Fixed asset at cost

Discarding of fully depreciated asset

Dr: Accumulated Depreciation
Cr: Fixed asset at cost
 17

Sales at book value

Dr: Cash/Bank/Accounts receivable
Dr: Accumulated Depreciation
Cr: Fixed asset at cost

Sales at less than book value

Dr: Cash/Bank/Accounts receivable
Dr: Accumulated Depreciation
Dr: Loss on disposal of fixed assets
Cr: Fixed asset at cost

Sales at more than book value

Dr: Cash/Bank/Accounts receivable
Dr: Accumulated depreciation
Cr: Gain on disposal of fixed assets
Cr: Fixed asset at cost

4. INVESTMENTS
Cost of investment
The cost of investment is the initial amount paid at the time of acquisition and
other related transaction costs.

Disposal of investments
Investments shall be disposed off with the approval of the Managing Director.
Gain or loss on disposal of an investment is recognized if there is difference
between the carrying amount of the asset and the net disposal proceeds from sale
of the asset.

Recording procedures
Initial investment
Dr: Investment
Cr: Cash/Bank/Account Payable

Sales at book value

Dr: Cash/Bank/Accounts Receivable
Cr: Investments at cost

Sales at less than book value

Dr: Cash/Bank/Accounts Receivable
Dr: Loss on disposal of investments
Cr: Investments at cost
 18

Sales at more than book value

Dr: Cash/Bank/Accounts Receivable
Cr: Gain on disposal of investments
Cr: Investments at cost

5. INVENTORY
The Company carries two types of inventory items:
• Chemicals and fertilizers purchased from foreign suppliers and principals
for further resale. The Company is sole agent for most of these items and,
therefore, there is no need of placing tender procedures for acquiring
them. The quantity to be imported is determined by the demand level that
is being monitored from bid advertisements. The purchase and resale of
these items is the main core activity of the Company.
• Stationeries and supplies acquired for consumption. These are expensed at
the time of purchase.

Purchase order
Purchase orders are initiated and authorized by the Managing Director. The
quantity of materials is determined by the prevailing demand in the market, based
on monitoring made by the Management from newspapers and other sources.

Goods in transit
Goods in Transit account shall be maintained for each order and costs incurred for
each order shall be accumulated in that account until materials ordered are
received. Upon receipt of the goods the balance in the Goods-in-Transit account
shall be transferred into stock account.

Receiving procedures
Pre-numbered Goods Receiving Notes (GRNs) are issued by the Store Keeper
upon delivery into store of imported goods. The following procedures are to be
followed before issuing GRNs.
• Quantity received shall be checked against quantity on Purchase Order,
Invoice, Packing list, Bill of Lading and other shipping documents.
• The amount charged on the Invoice shall be compared against the amount
on the Purchase Order.
• The quality of goods delivered shall be checked to ensure that it is as per
that on the specification.

Bin card
The Store Keeper shall maintain bin cards for each inventory item with
information on quantity received, quantity issued, remaining balance, location and
 19

source documents for incoming and outgoing movements on it. These cards shall
be kept on the same location with their corresponding inventory items.

Stock card
Automated stock cards shall be kept by the Finance Unit for all inventory items.
The stock cards shall carry the following information:
• Cost of inventory items received,
• Cost of quantity items issued,
• Cost of remaining balance, and
• Source documents for all transactions.

Cost of inventory
Cost of imported items includes the following.
• Invoice amount,
• Insurance charge,
• Freight charge,
• Customs duty and clearing charges,
• Other related costs.

Cost of locally purchased inventories comprise purchase price including import

duties, transport, handling costs and any other directly attributable costs, less trade
discounts, rebates, etc…

Issue voucher
Inventory items are issued out of the store against Issue Vouchers raised by the
Finance Unit and approved by the Managing Director. The Finance Unit raises
Issue Vouchers based on Cash Sales Invoices and Credit Sales Invoices.

The Finance Unit upon receipt of copy of Issue Vouchers adjusts the inventory
level based on the quantity and cost of goods issued.

Physical count
Periodic surprise counts can be made as required. A complete physical count shall
be made at least once in a year, preferably at year end, coordinated and supervised
by the Finance Unit and attended by external auditors.

Inventory sheets shall be used during the physical count. The inventory sheet
should show the quantity counted, the record balance, unit price, total value of
quantity counted, total value of record balance, overages and shortages. A
representative of the Finance Unit and the Store Keeper shall co-sign on all pages
of the inventory sheet confirming that all information contained in the inventory
sheet are correct.
 20

The balances on the ledger card, the stock card and the bin card shall be adjusted
to the physical count; and the Management shall decide on the discrepancies
discovered.

Valuation
Inventory items are shown at their actual individual costs.

Provision for stock obsolescence

Imported chemicals and fertilizers are expected to have shelf life of two years,
beyond which time they should be disposed-off. Adequate provision shall be
made for unsold items that have been held in stock for more than two years.

Reconciliation of balances
Stock ledger accounts and stock cards shall be maintained by the Finance Unit to
record movements of goods at cost.

Bin cards shall be maintained in the store to record the movement of goods in
quantity.

Periodic quantity reconciliation shall be made between the stock card and the bin
card usually before inventories are conducted.

Reconciliation of stock value balance shall also be made between the stock ledger
accounts and the stock card periodically.

Based on annual inventory stock shortages and overages shall be accounted upon
based on the decision of the Managing Director.

Source documents through which materials are issued, received and transferred
shall be maintained orderly and intact for future reference.

Recording procedures
Purchase of stationeries and supplies
Dr: Expense- Stationeries & Supplies
Cr: Cash/Bank/Accounts Payable

Foreign purchase- L/C opening and other payments

Dr: Goods in Transit
Cr: Cash/Bank/Accounts Payable

Delivery of goods into Store

Dr: Stock
Cr: Goods in Transit
 21

Cash sales
Dr: Cash/Bank
Cr: Stock
Cr: VAT account

Credit sales
Dr: Accounts Receivable
Cr: Stock
Cr: VAT account

Collection of accounts receivable

Dr: Cash/Bank
Cr: Accounts Receivable

Stock shortage
Dr: Responsible Store Keeper/Administrative Expense
Cr: Stock

Stock overage
Dr: Stock
Cr: Other Income

Provision for obsolescence

Dr: Expense
Cr: Provision for obsolescence

6. ACCOUNTS RECEIVABLE & PREPAYMENTS

“Accounts Receivable & Prepayments” encompass the following accounts:
• Trade Debtors,
• Advance to suppliers,
• Deposits,
• Purchase advance,
• Staff debtors,
• Sundry debtors,
• Prepayments, and
• Provision for doubtful debtors.

The Finance Unit shall maintain subsidiary ledger accounts for all debtors under
the above categories.

Trade debtors
Trade debtors arise from sales of goods on credit terms. All credit sales terms
need the prior approval of the Managing Director and VAT Credit Sales Invoices
shall be used for all credit sales. The Finance Unit shall check and confirm that
 22

unit prices on VAT Credit Sales Invoices are consistent with those on the
approved price list.

The Finance Unit shall make follow-up of all credit sales and their timely
collections. All outstanding balances shall be collected against pre-numbered
Cash Receipt Vouchers.

Advance to suppliers
Advance given to suppliers is in essence a lending transaction and shall be
recorded as receivable.

Deposits
Deposits are payments made in advance as a form of guarantee for contractual
services, e.g. customs, and any other transactions that require deposits. Since
deposits are recoverable in full, the Senior Accountant should review them on a
regular basis for their collections upon completion of their contractual
commitments.

Purchase advance
Under normal circumstances purchase advances shall be made direct to suppliers.
However when circumstances dictate such advances shall be paid through
company staff, and shall be recorded as receivable until they are duly settled.

Staff debtors
Loans and salary advances granted to company employees shall be recorded
individually to each employees account under “Staff Debtors” account. Staff
loans and advances shall be granted only by the approval of the Managing
Director and it should be cleared within the approved repayment period. No fresh
new loans shall be given before previous loans are fully repaid. The Senior
Accountant shall regularly review to verify that advances and loans are settled.

Sundry debtors
These are miscellaneous receivables originating from outside the main activities
of the Company such as credit sales of scraps and claims from various sources.

Prepayments
Prepayments include payments made in advance for use in the future. Cases that
fall under this category are insurance premiums, office rent and store rent paid in
advance.

Prepayments shall be analyzed regularly so that the required adjustments are

made to recognize expenses to the extent of benefits obtained.
 23

Doubtful debtors
All outstanding receivables shall be reviewed at year end and, based on aging
analysis, estimated future uncollectible or doubtful debtors shall be provided for
and accounts receivable shall be reported net of such uncollectible.

Recording procedures
Credit sales
Dr: Accounts receivable
Cr: Sales
Cr: VAT account

Settlement of VAT payable

Dr: VAT account
Cr: Cash/Bank

Collection of accounts receivable

Dr: Cash/Bank
Cr: Accounts receivable

Advance paid to suppliers

Dr: Advance to suppliers
Cr: Cash/Bank

Settlement of advance to suppliers

Dr: Cash/Bank
Cr: Advance to suppliers

Deposits
Dr: Deposits
Cr: Cash/Bank

Collections of deposits
Dr: Cash/Bank
Cr: Deposits

Purchase advance
Dr: Purchase advance
Cr: Cash/Bank

Settlement of purchase advance

Dr: Cash/Bank
Cr: Purchase Advance

Loans/Advances paid to staff

Dr: Staff Debtors- Name of staff
Cr: Cash/Bank
 24

Settlement of loans/advances
Dr: Cash/Bank
Cr: Staff Debtors- Name of staff

Payments & credit sales to sundry debtors

Dr: Sundry debtors
Cr: Cash/Bank/Sales
Cr: VAT account

Settlement by sundry debtors

Dr: Cash/Bank
Cr: Sundry debtors

Prepayments
Dr: Prepayments
Cr: Cash/bank

Adjustments made to prepayments for expenses incurred in the

period
Dr: Expenses
Cr: Prepayments

Provision for uncollectible

Dr: Bad debt expense
Cr: Provision for doubtful debtors

Write-off of bad debts

Dr: Provision for doubtful debtors
Cr: Accounts receivable

Collection from bad debt account already provided for

Dr: Cash/Bank
Cr: Other Income

7. CASH & BANK

Cash is the most liquid asset, so is highly susceptible to fraud and theft and,
therefore, needs utmost attention.

Company’s funds shall be kept in the Company’s safe custody and the safe shall
always be kept locked under the responsibility of the cashier.

Physical checking of cash on hand shall be made regularly by the Senior

Accountant and reported to the Finance Head with a copy to the Managing
Director.
 25

Collections
Collections from sales are made against pre-numbered VAT Cash Sales Invoices
and collections from debtors and other sources are made against pre-numbered
Cash Receipt Vouchers.

Upon receiving newly printed Cash Receipt Vouchers the pads shall be checked
to ensure that all leaves are intact and in their numerical order. The Finance Head
shall keep the unused pads in a locked cabinet and only one pad is issued to the
cashier against signature and against return of used pad which should be reviewed
for completeness. Spoiled and cancelled Cash Receipt Vouchers shall be marked
“VOID” and stapled in the pad.

All cash collections shall be immediately deposited into the Company’s bank
account intact against bank deposit slip.

Daily cash balance report showing all collections, deposits and payments shall be
prepared by the Cashier and reported to the Finance Head with a copy to the
Managing Director.

Credits to the Company’s bank account should be recorded based on bank credit
advices.

Petty cash fund

A petty cash fund of Birr 5000.00 shall be established by the Company for small
payments to be made in cash. Petty cash shall be kept on the imprest system
whereby the cashier is advanced a float of a fixed sum which shall always be
represented by cash or vouchers or both.

The maximum amount to be paid from the petty cash fund is Birr 500. All cash
payments are made against the Company’s “Petty Cash Payment Slip”. Petty Cash
Payment Slips are prepared by the Cashier, verified by the Finance Head and
Approved by the Managing Director.

After payment is effected all receipts and supporting documents are stamped
“PAID” and the corresponding payment voucher number is shown on all receipts
& attachments.

Replenishment of petty cash shall be made using “Petty Cash settlement Form”
when about 75% of the float is used. The summary form shall be prepared by the
Cashier, verified by the Finance Head and approved for replenishment by the
Managing Director.

Petty Cash payment Slips shall be coded when presented for replenishment.
Petty cash holders should not have access to accounting records.
 26

The Senior Accountant shall make surprise cash counts on a regular basis,
preferably weekly. Shortages shall be accounted as receivable from the Cashier.

Cheque payments
All payments in excess of Birr 500 shall be effected by cheque. Cheque payments
shall be ordered by pre-numbered payment vouchers that are approved by the
Managing Director. All required supporting documents shall be attached to
payment vouchers. Cheque payment vouchers and supporting documents shall be
stamped “PAID” and corresponding payment voucher number and cheque
number indicated on them after payments are effected.

Upon receiving new cheque book from the bank it shall be checked to ensure that
all leaves are intact and in their numerical order. Only one cheque book is issued
to the cashier against signature and against return of a completed cheque book
stub which should be reviewed for completeness. Spoiled and cancelled cheques
shall be marked “VOID” and retained in the cheque book. Bank accounts are
operated and cheques are signed by the Managing Director.

Cheque book stubs shall be completed with the details on the cheque issued and
the running bank balance indicated and updated from the bank book.

Cheques issued but remained outstanding or unpaid by the bank for six months
are considered as null and void and shall accordingly be adjusted in the books.

Unused cheque books shall be kept in a locked cabinet under the control of the
Finance Head until they are issued for use upon return of the completed cheque
stubs.

Blank cheques, signed or unsigned, shall never be issued.

The Cashier shall be authorized to collect bank advices, new cheque books, bank
statements and other correspondences from the bank.

Bank charges and other debits shall be recorded by the Company based on bank
debit advices.

Bank reconciliations
Bank reconciliations serve three main purposes:
• To arrive at the correct cash balance,
• To uncover errors and irregularities made by the bank or the Company,
and
• To provide information necessary to bring the accounting records up-to-
date.
 27

Bank reconciliation statement shall be prepared by an accountant who is not

involved in the preparation and issuance of cheques and shall be checked and
approved by the Finance Head. The statement with the reconciled balance shall be
reported to the Managing Director on a monthly basis.

Recording procedures
Cash collections through Cash Receipt Voucher
Dr: cash
Cr: Account affected

Cash collected through VAT Cash Sales Invoice

Dr: Cash
Cr: VAT account
Cr: Sales

Cheque payments
Dr: Account affected
Cr: Cash in bank

Petty cash fund establishment

Dr: Petty cash fund- Cashier
Cr: Cash in bank

Petty cash replenishment

Dr: Account affected
Cr: Cash in bank

Petty cash fund termination

Dr: Cash in bank
Cr: Petty cash fund- Cashier

Bank transfers
Dr: Account affected
Cr: Cash in bank

Bank debit advices

Dr: Account affected
Cr: Cash in bank

Bank credit advices

Dr: Cash in bank
Cr: Account affected
 28

8. ACCOUNTS PAYABLE
The Company will have the following set of accounts under Accounts Payable.
• Trade creditors,
• Advance from clients,
• Bank loans and overdraft,
• Taxes payable,
• Accrued liabilities, and
• Long term loans.

Trade creditors
This is the account where amounts due to suppliers of goods and services are to
be recorded.

Advance from clients

Advance received from clients based on sales contracts shall be recorded as
liability.

Bank loan & overdraft

Under this category we have term loan or overdraft facility obtained from banks
for financing the Company’s operations.

Taxes payables
The following government taxes shall be collected and paid promptly according
to set schedules.
Profit tax
This is the amount provided for taxation on the profits of the year under
review plus any unpaid arrears of profit tax.

Withholding tax
2% tax shall be withheld from payments made to suppliers of goods and
services as per the income tax law.

Amount withheld from suppliers shall be recorded as liability during the

month of collection and should be paid to the Tax Authority within the
first 10 days of the following month.

Value added tax (VAT)

15% VAT shall be collected on sales of goods and services as provided in
the VAT law and shall be credited to the VAT account to recognize VAT
payable.

The net amount shown in the VAT account shall be declared and paid to
the Tax Authority during the next month following the transaction.
 29

Payroll tax
Income tax shall be withheld from the taxable earnings of employees as
provided in the Income Tax Law. Income tax collected shall be paid the
Tax Authority within the next month following collection.

Accrued liabilities
The common types of accrued liabilities or expenses are utilities, salaries and
interest on borrowed funds. At the end of the year liabilities shall be recorded for
materials and services received even if invoices have not yet been received.

Long term loans

Medium or long term loan shall be arranged by the Company when there is a need
to finance capital investments such as purchase of heavy equipment or
construction of office and store buildings.

Recording procedures
Credit purchase
Dr: Account affected
Cr: Trade creditors

Settlement of trade creditors

Dr: Trade creditors
Cr: Cash in bank

Advance received from clients

Dr: Cash in bank
Cr: Advance from clients

Utilized overdraft
Dr: Account affected
Cr: Overdraft

Interest on overdraft
Dr: Interest expense
Cr: Overdraft

Repayment/Deposit into overdraft account

Dr: Overdraft
Cr: Account affected

Withholding of tax from clients

Dr: Account affected
Cr: Withholding tax payable
 30

Settlement of withholding tax

Dr: Withholding tax payable
Cr: Cash/Bank

VAT collection from cash sales

Dr: Cash
Cr: Sales
Cr: VAT account

VAT collection from credit sales

Dr: Trade debtors
Cr: Sales
Cr: VAT account

Settlement of VAT payable

Dr: VAT account
Cr: Cash/Bank

Withholding of payroll tax

Dr: Account affected
Cr: Payroll tax payable

Settlement of payroll tax

Dr: Payroll tax payable
Cr: Cash/Bank

Accruals
Dr: Account affected
Cr: Accrued expense (Liability)

Reversal of accruals with settlement of actual invoice

Dr: Accrued expense (Liability)
Cr: Cash/Bank

Obtaining fund from long term loan

Dr: Bank
Cr: Long term loan

Recognizing current portion of long term loan

Dr: Long term loan
Dr: Interest expense
Cr: Current liability
 31

Settlement of current portion of long term loan

Dr: Current liability
Cr: Cash/Bank

9. DIVIDEND
At year end shareholders shall decide the amount to be distributed as divided from
the realized profit. 10% tax shall be withheld from dividend declared and it shall
be paid to the tax authority within 15 days in the following month.

Recording procedures
Declaration of dividend
Dr: Profit & Loss account
Cr: Dividend payable
Cr: Tax Payable

Payment of Dividend
Dr: Dividend payable
Cr: Cash at bank

Settlement of tax
Dr: Tax payable
Cr: Cash at bank

10. PAID UP CAPITAL

Paid up capital is the amount paid in or contributed by the shareholders of the
Company in the form of liquid cash or other assets and which is registered in the
Company’s Article of Association. Currently the Company’s paid up capital is
Birr 800,000; fully paid for the 800 shares issued with par value of Birr 1,000 per
share.

Recording procedures
Dr: Cash/Bank/Other assets
Cr: Paid up capital

11. LEGAL RESERVE

The Company shall transfer at least 5% of its profit into legal reserve fund each
year until such fund amounts to 10% of the capital.

Recording procedure
Dr: Profit & Loss account
Cr: Legal reserve fund
 32

12. PROFIT AND LOSS ACCOUNT

Profit and loss account represents the amount generated by the Company from its
operation reduced by dividend paid and amount transferred to legal reserve.

Recording procedures
Closing of accounts at year end
Dr: Revenue
Cr: Profit & Loss account

Dr: Profit & Loss account

Cr: Cost of goods sold
Cr: Expenses

Dividend
Dr: Profit & loss account
Cr: Dividend payable

Transfer to legal reserve fund

Dr: Profit & loss account
Cr: Legal reserve fund

13. REVENUE/SALES
Revenue/income arises from the following sources.
• Supply of goods or services on cash or credit sales terms,
• Interest or dividends received on trade investment, and
• Sales of items of miscellaneous nature such as sales of scraps.

Measurement of revenue
Revenue shall be measured at the amount received or receivable.

Recording procedures
Advance received on contract
Dr: Cash at bank
Cr: Advance from clients
Cash sales
Dr: Cash at bank
Cr: Sales
Cr: VAT account

Credit sales
Dr: Accounts receivable
Cr: Sales
Cr: VAT account
 33

Collection of accounts receivable from credit sales

Dr: Cash at bank
Dr: Advance from clients
Cr: Accounts receivable

Other income
Dr: Cash/Receivable
Cr: Other Income
Cr: VAT account

14. COST OF GOODS SOLD

Every batch of goods imported shall be considered as a separately identifiable
inventory item where all expenses incurred for each batch are charged directly to
that inventory item.

Recording procedures
Opening of LC/CAD
Dr: Goods in transit
Cr: Cash at bank

Settlement of invoice, insurance, freight, customs, inland costs, etc…

Dr: Goods in transit
Cr: Cash at bank

Delivery of goods to store

Dr: Stock- with inventory number
Cr: Goods in transit

Sales of imported goods

Dr: Cost of goods sold
Cr: Stock- with inventory number

Dr: Cash/Bank/Accounts receivable

Cr: Sales
Cr: VAT account

15. GENERAL & ADMINISTRATIVE EXPENSES

General & administrative expenses are those operating expenses incurred in
supporting the sales activities and that cannot be directly classified or charged to
sales. Examples are research & development expenses, utility expenses, audit fee,
stationery and supplies.
 34

Recording procedures
Dr: Account affected
Cr: Cash/Bank/accounts payable

16. JOURNAL VOUCHERS (JVs)

Journal vouchers are used for non-cash transactions such as accruals, adjustments
of prepayments, reversals of entries passed earlier, to record summarized data of
cash transactions, etc…

Journal vouchers should be:

• Adequately supported,
• Prepared in one original and one copy; the original being an accounts copy
and the copy to be filed in numerical order,
• Correctly coded,
• Signed for preparation, checking and approval; and
• Posted to the respective accounts and signed for doing so.

In case reversals are made to correct previously recorded entries, JVs should be
cross-referenced with documents previously processed.

Journal Vouchers shall be prepared by the Senior Accountant and verified by the
Finance Head.

17. PAYROLL
The Senior Accountant shall maintain and update all the necessary information
required for the preparation of monthly payroll such as:
• Employment letter,
• Basic salary,
• Benefits,
• Attendance sheet,
• Agreed deductions,
• Identification number, and transfer and dismissals.

The Senior Accountant shall prepare the payroll based on the attendance sheet
approved by the Managing Director. The Finance Head shall verify the payroll
sheet and the Managing Director approves it.

Current month payroll shall be verified with the previous month payroll and items
of variations shall be identified and supported by authenticated documents.

Salary shall be paid on the 1st day of each Gregorian month for employment in
the previous month. Cheques shall be issued to each employee based on the net
 35

amount shown on the payroll. Salary and other payments of deceased employees
shall be withheld until the beneficiary is determined by court order.

Third party deductions should be made as per agreed schedule and paid to the
appropriate beneficiary.

Income tax chart

Employees’ income tax shall be collected from taxable earnings as per the
following chart.
Taxable Income Tax Rate (%) Exemption (Birr)
Up- to 150 0 0.00
151 to 650 10 15.00
651 to 1,400 15 47.50
1,401 to 2,350 20 117.50
2,351 to 3,550 25 235.00
3,551 to 5,000 30 412.50
5,001 & above 35 662.50

Recording procedures
Accrual of salary
Dr: Salary expense
Dr: Employee benefits
Cr: Payroll tax payable
Cr: 3rd party deductions payable
Cr: Salary payable

Salary payment
Dr: Salary payable
Cr: Cash at bank

Settlement of payroll tax payable

Dr: Payroll tax payable
Cr: Cash at bank

Settlement of 3rd party deductions

Dr: 3rd party deductions payable
Cr: Cash/Bank

Recording unclaimed salary

Dr: Cash at bank
Cr: Unclaimed salary

Payment of unclaimed salary

Dr: Unclaimed salary
Cr: Cash at bank
 36

18. SECURITY
Control
The reliability of accounting systems and accuracy of accounting information are
all dependent on an adequate system of security controls being implemented.
System security is the protection of computer facilities, equipment, software and
data from destruction by:
• environmental hazards (such as fires, water, etc.),
• intentional damages on equipments and software,
• human errors, or
• computer abuse.
Having a good system of security control is very important in a computerized
working environment. System security controls prevent failures in system
security, detect failures in system security, and help recovery from failures in
system security.
The Company should put in place the following security measures:
• Establish a security and monitoring plan including a disaster recovery
plan.
• Assign responsibilities for implementation of its security plan and
monitoring the system on a continuous basis.
• Test the system security to ensure that:
o Responsibilities are fully assigned,
o Procedures are understood and followed, and
o Control devices function properly.

Access control
The Company should ensure that:
• Access to computer facilities has been limited to authorized personnel.
• Authorization scheme has been implemented to identify and assign:
o Authorized users,
o User identification codes & passwords,
o What modules in the program each user may access, and
o User’s operation access rights.